National Institute of Economic and Social Research

Tuesday, 24 January 2012

Fiscal space: what does the IMF mean?

The IMF, now under new management, is being increasingly vocal in saying that countries which can afford to do so should be slowing the pace of fiscal adjustment, and that failure to do so will damage growth. They've used some strong language again today, saying:

"those [advanced countries] with very low interest rates or other factors that create adequate fiscal space, including some in the euro area, should reconsider the pace of near-term fiscal consolidation. Overdoing fiscal adjustment in the short term to counter cyclical revenue losses will further undercut activity, diminish popular support for adjustment, and undermine market confidence."

But for understandable reasons, the Fund is reluctant to be too specific about individual countries, so we have to work out who they really mean. "Low interest rates" is pretty clear - that refers to most advanced countries outside the eurozone, especially the US (and UK), as well as Germany and a few others within it. But what does "fiscal space" mean? (I was just asked this, not unreasonably, on the BBC). The term is not well defined, but helpfully some Fund economists have tried to do just that, in a paper which is summarised here. This is the key chart:

In this chart, "fiscal space" refers to the difference between projected 2015 debt levels and the "debt limit" - basically, the point at which things start to go badly wrong; so it is a quantitative measure of countries' room for manoeuvre, or scope for changing/easing policy, over the medium term.

The bottom line here is that there is a group of countries with little or no fiscal space, like Greece. Then there is a group with a fair amount, estimated at 50% to 100% of GDP. As the authors say, the precise estimates should not be taken too literally, but this clearly implies that countries in this group have significant scope for fiscal flexibility over the short to medium term. This includes most of the G7 - US, UK, France, Germany, perhaps Canada. And then finally there is a group of mostly smaller countries which have considerably more space and substantial scope for flexibility, but from a global perspective their fiscal policies probably don't matter much.

So a reasonable interpretation would appear to be that the Fund thinks that most of the major advanced economies, including the US, UK and Germany, have enough fiscal space to "reconsider the pace of near-term fiscal consolidation".